US tax reform – Cuts in the US but at what cost?

Hillary Clinton in her book “What happened” mentions Joe Biden’s don’t tell me what you value, show me your budget and I’ll tell you what you value. Replace “budget” with “Tax Cuts and Jobs Act” and Mr Biden’s point is still valid in interpreting the recent unveiled US tax reform plan: The clue is in the title of the proposed act. I know, the irony of citing a Democrat on a Republican tax plan!

An initial estimate from the Joint Committee on Taxation projects that the bill as released would result in a 10-year deficit spike of $1.5 trillion. Certain commentators, for example Lawrence Summers of Harvard and a former US treasury secretary argues that Congress should return to the 1986 approach of revenue neutral tax reform noting that the deficit is already on an increasing path without this approach being taken. However the Bill has a long way to go before it is passed.

The bill, as initiated, brings about significant changes (from decreasing corporate tax rates to abolishing the inheritance tax) so what follows is a brief look at just some of those relevant from an Irish corporate tax perspective.

The TCJA would reduce the general corporate tax rate to 20% effective as of January 1, 2018 which is down from a maximum tax rate of 35%. The rate reduction would be immediate rather than implemented using a phased approach. When we sought to bring in our 12.5% rate we didn’t do it overnight but rather took almost 5 years to realise that goal.

When the US plan was first announced earlier this year a rate of 15% had been suggested. It was commented on then that such a major cut in US corporation tax would make it more favourable for US firms to manufacture at home. But this time the more controversial aspects of the proposal, being the new excise tax and deemed repatriation, would have to be considered.

Under the excise proposal, certain tax deductible payments made by a US company to a related foreign company which is a member of the same “International Financial Reporting Group” (which could be Irish) are subject to a 20% “excise tax”. The Bill excludes from the definition of IFRG any group whose annual average of total specified amounts from US members to foreign members does not exceed $100 million for the current and two preceding years.

As this proposal would impose full US tax on common business transactions including royalties paid to and inventory acquired from foreign affiliates, it would have an adverse impact on a wide range of large multinationals, both US- and foreign-parented. The proposal applies to amounts paid or incurred after December 31, 2018.

This isn’t a million miles away from the Border Adjustment Tax which had been suggested earlier this year before the first draft of the tax plan had been unveiled. At that time Republicans had announced they would scrap plans for a US border adjustment tax which was an effective levy on imports. It was reported that this would have hit Irish exports to the US hard especially for the many US manufacturers based here as well as domestic exporters.

We know that almost 70% of IDA client firms in Ireland are American and the plans would have had consequences in particular for the medical devices and pharmaceuticals sector. It’s clear that this significant issue is now back on the agenda. However, Kevin Brady who is one of those behind the bill has made public statements that in response to comments the House Ways and Means Committee is actively considering modifications to this provision.

One of the TCJA’s key reforms for businesses is a transition from the current worldwide taxation regime to a “territorial system” for taxing foreign-source income of US multinationals. This is intended to make US businesses more competitive on a global playing field. We’re looking at doing something similar as part of our current Department of Finance public consultation following the Coffey report on corporation tax. Consultation on such significant issues in Ireland is critical because as I’ve said before consultation with us decreases consternation amongst us.

Our consultation, which ends at the end of January next, also suggests an exemption for foreign dividends from certain foreign companies received by Irish resident companies. The US is suggesting something similar in that certain US corporations that are shareholders of a foreign corporation (e.g. certain 10-percent-owned foreign corporations) will have a 100% dividends received deduction on the foreign-source portion of any dividends paid by the foreign corporation.

That said, a once off deemed repatriation tax is suggested as a form of quid pro quo for the above. In general, a US shareholder company owning at least 10% of certain foreign subsidiaries should include in its income, in its year in which the subsidiary’s last tax year beginning before 2018 ends, its share of the accumulated post-1986 deferred foreign income of that foreign subsidiary. The amount of such deferred income generally takes into account earnings and profits as of November 2, 2017, or December 31, 2017 (whichever is higher) without a reduction by reason of dividends distributed in the year that includes such date. The netting of earnings and deficits takes into account the US shareholder’s earnings and profits deficits of foreign subsidiaries of the US shareholder or members of the US shareholder’s affiliated group.

The US shareholder can claim a deduction against the above income which would result in US tax of 12% of the income inclusion (to the extent of the shareholder’s share of its subsidiaries’ “cash positions”) and 5% for the remainder. This tax can potentially be reduced by a foreign taxes deemed paid upon the inclusions. So a US company holding shares in an Irish company may be subject to this tax but if that Irish company has paid tax at home then the US tax may be reduced.

On a similar note a provision is made for US shareholder companies to include 50% of its certain foreign subsidiaries’ net income for the year that represents “high” returns on investment as part of its income. This would ensure that the “high returns” on certain foreign subsidiaries’ income will bear current worldwide income tax at a rate of no less than 10% subject to certain reduced foreign tax credits. Like deemed repatriation if passed this will add significantly to the administrative burden on US groups with additional costs depending on the tax relief given.

Senator Bob Corker, who has commented on a wide range of issues since announcing that he won’t seek re-election to the Senate in 2018, has stated publicly that “tax reform is going to make health care look like a piece of cake.” The challenge of complying with various procedural limitations in the Senate as well as parsing potentially difficult political issues is likely to show how true that statement is.

This article first appeared in the Sunday Independent of November 12th, 2017.

About the author

Partner - Tax

Tom leads the firm’s Tax Policy and Technical Services team. He works closely with our client teams to deliver the insights they need to address their most complex business issues. Tom provides tax ad... More

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